Hammer candlesticks are a popular reversal pattern formation found at the bottom of downtrends. They consist of small to medium size lower shadows, a real body, and little to no upper wick. This shows a hammering out of a base and reversal setup. These candles are typically green or white on stock charts. Look for a break above the candle to confirm the reversal. Traders would place their stop loss below the hammer’s low if the price reverses.
A hammer candlestick is typically found at the base of a downtrend or near support levels. Hammer candlesticks comprise a smaller real body with no upper wick and a long lower shadow. They are typically green or white on stock charts. Hammer candlesticks are bullish reversal signs. See a lot of the hammer candlesticks in downtrends. Hammers do not always stop a downtrend. Look at the news surrounding that stock because emotions affect price movement.
This pattern forms when a base is being hammered out. The stock trades significantly lower than the opening price but rallies later in the day to close at or above its opening price.
You tend to see a hammer candle in stock in a downturn. This is because it is finding its base. However, just because it has found its base does not mean the bulls are returning. They are gaining strength, though. Whereas doji candlesticks show indecision, hammer candlesticks are reversal candles. Getting confirmation is always good.
Hammer Candlestick Basics
The meaning of a hammer candlestick can be defined as finding support through panic selling. The wick shows that sellers drove prices low that day. However, it had a strong finish, indicating buyers returned at the end of the day.
A hammer candle pattern is most effective when at least three declining candles are in a row. A declining candle shows panic selling. Each day has a lower low, illustrating the fear and panic selling continuing.
Shorts can be a part of this as well. They see these declining prices and decide to sell short. But, again, the bears are in control. Now, the bulls may notice how inexpensive a stock has become, and suddenly, it looks attractive to them.
A high-wave candlestick or a long-legged doji candlestick could be forming instead of a hammer candle. That’s why you should wait for confirmation. You can look at the pattern instead of getting hung up on what each candle is.
Hammer Candlesticks Example
This is an example of $GLD on a daily chart. You’ll notice two hammers that are highlighted. The large green one formed a solid base. Then, the price increased short-term and fell again, creating another hammer. This is close to a double-bottom pattern.
The pattern continued to consolidate and made a run, but not a total breakout. It formed a rising wedge pattern that ultimately broke into a large megaphone pattern. Hammers can also form in uptrends, which are considered hanging man candles. An upside-down hammer is called an inverted hammer. Inverted hammers can also happen near support levels and show a potential bullish reversal is about to take place.
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How to Trade Hammer Candlesticks
- Traders take a long position when the price breaks above the candlestick’s high.
- They use a candlestick close below the low as a stop level.
- Take a short at the break of the low and use a candlestick close above as a stop.
Trading the Charts
This is an example of a large hammer candlestick on the $SPY. The gray-shaded area was the premarket. Notice the horizontal lines going across. That was premarket support and resistance levels. Do you notice how the price traded in a channel near the lows during the premarket, and then the hammer formed?
This is key to be aware of because this was signifiying that premarket lows were holding during the open. After the hammer formed, a bull flag ended up forming. The price formed a large rising wedge pattern and broke above the premarket high.
A hammer candlestick chart pattern can be confirmed when the candlestick after the hammer candle has higher lows. The price rise could be short sellers covering their positions. That is why it is important to wait for a bullish confirmation.
The wick on a hammer chart pattern shows there are still plenty of sellers. It would be best if it had more buying pressure and volume. Because hammers show, there are still a lot of sellers, and a lot of volumes can go a long way to reinforce how good the reversal is.
Frequently Asked Questions
Hammers found near the base of downtrends are signaling a bullish reversal. Traders would look to enter into a long position once the price breaks above the hammer. If someone is in a short trade and they see a hammer form, this is where they look to cover their position.
A green hammer formed near support levels signifies that the bulls are in control and looking to increase the price. A red hammer signifies that the bears were trying to take control, but the bulls came in. They both can signify reversals to the upside. A red hammer found near resistance is considered a hanging man candle.